Status Quo for Crown Castle in Q2: Towers Look Good While Small Cells Lag

Business Strategy & Outlook:

Crown Castle’s strategy has deviated from that of its two biggest competitors, which focus almost exclusively on towers and have a multinational footprint. Crown operates exclusively in the United States and is aggressively investing in fiber to pursue small-cell communications sites. Crown Castle has adopted a high-risk strategy. Small cells require heavy initial investment and lack the competitive advantage that Crown has with its towers.

Crown’s legacy tower business (70% of total revenue in 2021), where it leases space on its towers to wireless carriers, which install antennas and other equipment. The carriers enter long-term leases with Crown that include rent escalators (annual increases of about 3%), giving the business a highly visible and stable revenue stream. Towers are also the beneficiaries of the explosion in mobile data use, which has been growing 30%-40% per year in the U.S. To meet the demand, carriers either locate equipment on additional towers or add or modify equipment on existing towers. Significant operating leverage makes both alternatives highly profitable for Crown–additional tenants and equipment upgrades can be added to towers for very little incremental cost. Towers will continue to be an integral part of the long-term mobile network solution. Since 2017, Crown has focused its investment on fiber and building small cells rather than towers. Management emphasizes that the fiber will be very lucrative when it can co-locate additional tenants on fiber it has already built, but it has yet to show significant colocation demand. The skeptical significant colocation demand will ever come to fruition, as AT&T and Verizon each own a lot of fiber on which to build small cells. Over the past five years, about 75% of Crown’s total capital spending has been on fiber, yet growth in the much smaller fiber segment still has not been able to outpace tower revenue growth.

Financial Strengths:

Although Crown Castle is highly leveraged, the steady cash flows it receives from its tower business allow it the financial flexibility it needs and alleviate any concerns about its ability to service its debt. The firm closed 2021 with a net debt/EBITDA ratio of 5.4 times, above the 5 times EBITDA ratio it targets, but its interest coverage ratio (adjusted EBITDA/interest expense) was also over 5.0. At the end of 2021, Crown had more than $450 million in cash and access to $5 billion on its revolving credit facility. As a real estate investment trust, Crown Castle is obligated to make dividend payments of at least 90% of its REIT taxable income (excluding income from its non-REIT subsidiaries) each year. In recent years, the payout ratio has been well in excess of 100% of free cash flow, but capital spending is now declining, so don’t expect a change to the roughly 7% annual dividend increases or the firm’s stance that it can do so without having to raise equity or materially increasing its leverage ratio.

Bulls Say:

Crown Castle is at the forefront of an industry transition toward small cells that will be necessary with 5G networks.
Carriers will have to continue investing heavily in their networks as mobile data usage continues increase by more than 30% each year in the U.S., and Internet of Things and video trends make that pace likely to continue.
Crown is virtually assured stable growth in its tower business. It holds long-term leases with contractual rent escalators, and its costs have similar certainty and are highly leverageable.

Company Description:

Crown Castle International owns and leases roughly 40,000 cell towers in the United States. It also owns more than 85,000 route miles of fiber. It leases space on its towers to wireless service providers, which install equipment on the towers to support their wireless networks. The company’s fiber is primarily leased by wireless service providers to set up small-cell network infrastructure and by enterprises for their internal connection needs. Crown Castle’s towers and fiber are predominantly located in the largest U.S. cities. The company has a very concentrated customer base, with more than 70% of its revenue coming from the big three U.S. mobile carriers. Crown Castle operates as a real estate investment trust.

(Source: Morningstar)

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